What You See Is Not Necessarily What You Get

As we hit the halfway mark on the calendar year, it’s worth reflecting on the expectations we outlined in our 2014 preview. If you recall, we emphasized that “it is quite possible, almost probable that 2014 will be a better year for the economy than it will be for the stock market”. Were we wrong? So far this year, reality seems like a mirror reflection of our expectation, for the stock market (as represented by the S&P) is up 6.95%, while the economy (as measured by the Gross Domestic Product (GDP) in the first quarter) appears frighteningly weak. Notice however that we used the phrase “seems like” rather than “is” a mirror reflection of this expectation. Often times what you see is not necessarily what you get.

It is an exercise in futility trying to estimate stock market performance based on GDP. More broadly, the first half this year is one of the clearest signals that market participants who spend their time trying to guess which direction the broader economy will go, too often mistake the forest for the trees. While GDP is obviously a good proxy
for the direction of corporate earnings, it is far from perfect. Moreover, GDP does not tell us anything about how companies are valued, and where those corresponding values will go over time. There are two implicit points here in our knock on GDP as a tool for stock market timing: 1) it is an extremely challenging task to predict what the rate of change in GDP will be one quarter out, let alone one year out; and, 2) even were one to know in advance what GDP would do the next quarter, it does not follow that one would then be able to use that information profitably in the stock market.

This is but one part of why we are strong believers in learning our companies through-and-through, familiarizing ourselves with the sectors within which they do business, and understanding the general context of the economy around them, without shifting our thesis on outstanding businesses based solely on the ebbs and flows of the macro economy.

So where does that leave us with regard to our seemingly very wrong assessment of the general landscape for 2014? Well, given recent stock market performance, we clearly aren’t too disappointed in being wrong. However, we do think that we are still far more right than it may appear. While the S&P is off to a great start in 2014, the Russell 2000 is up half as much as the S&P, or 3.26%. This is evidence that a few large cap multinationals have been pulling up the vast majority of stocks, while the average stock has been, “quite average,” for lack of a better word.

Meanwhile the extremely negative Q1’14 GDP number is far less negative than it appears. Note that GDP numbers go through many revisions before they are finalized. Importantly, this particular Q1’14 GDP number was drastically impacted by the inclement weather affecting much of the country. Typically, GDP moves alongside Personal Consumption Expenditures (PCE), which measures the amount of money that households spend, and while GDP was negative, PCE remained positive All in all, we also still do not know the Q2’14 GDP, and thus cannot speak to the first half in its entirety; however, it’s fairly clear from the context of an amalgamation of leading indicators such as
hours worked, durable goods orders, and the Purchasing Manufacturers Index (among other reference points) that the economy has/is accelerating rather than slumping.

Taken as a whole, we think our expectation that 2014 will be a better year for the economy than the stock market remains the correct overall framework when constructing portfolios. As we discussed over recent quarters, we continue to carry a healthy cash balance, we have little to no exposure to the momentum segments of the market, and we have built a substantial allocation to global equity markets.

Author: Jason GilbertJason explains about himself:
I've been managing money for high net worth individuals since 2006. I'm the founder and Managing Director at RGA Investment Advisors LLC, an independent and fee-only registered investment advisor (RIA).
I'm the partner in charge of wealth management and financial planning at Rayner and Gilbert CPAs. Prior to a career in wealth management and investment advisory,
I held M&A roles at both General Atlantic LLC (GA), a leading global private equity firm providing capital for growth companies driven by information technology or intellectual property, as well as Berkery, Noyes & Co. (BNC), an independent Wall Street investment bank serving the broadly defined knowledge and information marketplace. At GA, I was responsible for deal prospecting, transaction structuring, as well as value added portfolio work. At BNC I specialized in serving large and mid-sized information providers in the U.S. and international markets with strategic mergers & acquisitions, corporate and asset divestitures, strategic research, and valuations.
Prior to a career in Finance, I led the due diligence efforts for numerous financial buyers within KPMGs Transaction Services practice, and provided estate planning tax consulting services at the law firm of Buchanan Ingersoll, PC in Washington, DC. I am a CPA who holds the PFS* designation for my expertise in Personal Finance and a CFF** for my accreditation in Financial Forensics.
I hold a B.A. from the University of Michigan and an M.S. in Accounting and Finance from the George Washington University School of Business. I lives in New York with my beautiful wife Julianna, two sons, Logan and Henry, and dog, Samantha